FACTORING - No longer a deal with the Devil.

Handing over your sales ledger to a factor was once viewed in the same league as Dr Faustus flogging his soul off to the Devil – a path of illusory riches that would lead only to inevitable business ruin and damnation. Over the last decade, the factoring and invoice discounting industry has gone into overdrive to shed its old reputation as a last chance saloon providing finance against outstanding debtors’ balances to clapped out businesses. Factoring is certainly attracting more and more customers. A survey last month by HSBC Invoice Finance of more than 4,700 UK companies found that businesses choosing factoring as an alternative finance could grow from 10.8% now to 23% over the next five years. Some opt for full factoring services, which involves the handover of a company’s sales ledger, others prefer invoice discounting because they want to retain their sales ledger. Factoring companies buy your trade debtors and pay a percentage, usually in the region of 80% to 85%, of the approved debts as soon as they receive an invoice. Read the publicity from around 60 UK companies offering factoring and invoice discounting and you could believe the industry is now a benign fairy godmother ready to bring in overdue money, cash flow and good fortune. But, as all arrivistes know, respectability is never easy to buy – even as annual turnover among Factors and Discounters Association members climbed 13% last year to more than #64bn. And accountants dealing with small to medium-sized businesses – SMEs form the majority of 26,000 businesses currently using factoring houses – are as aware of the industry’s reputation as their clients’. ‘People’s problem accepting factoring services is a psychological one rather than a straight financial issue,’ says Ian Smart, who heads up the corporate finance department at Grant Thornton. ‘Factoring has become more acceptable, but there is still a degree of reluctance and distrust among many over releasing control of their sales and credit arrangements. ‘People have a similar problem with handing over their sales ledger as they do with losing sovereignty of their currency, or taking on any form of indebtedness whatsoever. ‘Companies often want to retain independence and be left running their own sales and credit facilities, and not to be reliant on another organisation to do that.’ He says despite its recent efforts, the industry’s reputation still deters many companies, who believe the stigma of factoring could drive away customers and counter weigh any benefits from freeing up cash flow. Smart says the loss of control is similar to outsourcing other business activities, such as catering or accounts department. ‘Factoring is one of a range of financial services now on offer to modern businesses, and it’s down to specific business needs,’ says Smart. ‘In the security industry, where smaller firms provide services to large multiples and retailers, factoring is seen as a highly effective way to finance sales ledger. ‘Raising finance can be difficult for any business, and if a company needs to finance growth it can be a valuable option when other alternatives have been closed off.’ Factoring houses argue that over-reliance on the overdraft slows down growth particularly in small to medium-sized businesses’ looking at their previous rather than up and coming sales. And according to the HSBC, reliance on the traditional overdraft could fall by around 13% to less than half the slice of the financial services market. Steve Bottomley, head of HSBC Invoice Financing, says: ‘Businesses are waking up to the fact that maybe a bank overdraft secured on a second mortgage on your house is not the best way to go about financing your business.’ He argues that the advantage of factoring in a fast-changing environment is that your financing is linked to, and goes up directly with, your sales, while a traditional overdraft can ‘mask problems’ within a business. ‘By the time a company knows what is going wrong it is usually far too late,’ he says. ‘Companies only find there is something fundamentally wrong when they are refused a request for excess on an overdraft. And if you’re starved of cash, you risk going out of business.’ Teresa Graham, a partner at Baker Tilly, is more circumspect and believes businesses need to think hard before adopting factoring services. ‘There is a great difference between what companies ask themselves and what they should ask themselves before they opt for factoring as a financial alternative,’ Graham says. ‘But, anyone thinking about using factoring needs particularly to ask “is my top line growing?” Factoring is expensive and will only pay off if you have got decent enough levels of growth, so that you don’t have to go to the bank to cover charges every five minutes.’ While she says confidential invoice discounting will always appear on her list of financial options for clients, she would only recommend factoring if it was the only way to go. ‘I am not a great supporter of having someone take over control of your sales ledger,’ she says. ‘Whatever the industry says, small to medium-sized businesses are still very nervous and will continue to be about the factoring industry and will prefer confidential discount financing.’ FDA chairman David Marsden is understandably more assertive about factoring’s benefits: ‘Factoring provides the complete answer to slow-paying customers, shortage of working capital and, if needed, protection against bad debt losses.’ Paul Sanders, commercial director at Alex Lawrie Factors, says factoring gives businesses extra money up-front to bargain with suppliers, and take advantage of options such as bulk purchasing or prompt payment discounts. ‘We offer expert credit control and collection of unpaid invoices that gives speedier cash flow, which in turn means a reduced working capital need and lower overdraft charges,’ Sanders says. Chartered accountant and Federation of Small Businesses spokesman, Neil Harper does not agree: ‘I do not recommend factoring to my clients,’ he says. ‘It is great if you have exponential business growth, but if sales level out after three months it can become an expensive service and is very difficult to get out of if the dip continues.’ He says that out of three clients he knows who have adopted factoring, one wishes after two years that he had never gone down that road, another is stuck because sales are not high enough to generate the funds to get out and the third has opted out. ‘There is just not sufficient flexibility for small to medium-sized businesses,’ he says. ‘You can’t opt for periods of non-growth when your sales need to plateau and you consolidate business, because the factor needs more invoices and cash flow.’ However, Bottomley cites the example of a prospective client in computer business-to-business wholesale who has adopted e-commerce trading methods and has grown to a #50m turnover. ‘He has moved from being a stockist to a virtual company and over 50% of sales coming over on the website rather than telephone or fax. ‘What he is now talking about is finance, and that has to be forward-looking rather than backward-looking, but his real drive is credit control and to find someone who can collect for him.’ Finding that factor can itself be a difficulty, according to Robert Coyle, who heads up a new broking service for PricewaterhouseCoopers’ business recovery services unit. ‘Many companies looking at factoring find it difficult to assess who might be the right factor for them – there are a bewildering range of factors, most of them not household names.’ Bottomley says: ‘There are 60-odd factoring businesses in the UK and you’ve got to make the decision on how much time you’ve got to do your research, what sort of service you are looking for and how much you want to pay.’ … the devil, as they say, is in the detail. QUESTIONS TO ASK A FACTORING FIRM – Finance – How quickly would finance be available against invoices and amounts collected from my customers? – Efficiency – How quickly can you collect payment of my invoices from my customers? – Contact – Who would be the day-to-day contact and would that person speak to my customers? – Trading overseas – Would you be able to handle collection of my invoices if I were to begin exporting? – Costs – What costs are involved with the service? – Guarantees – What sort of personal guarantees are sought? – Background – Who owns your company? Are you a member of the Factors and Discounters Association? What experience do you have in my market? – Setting up the agreement – How long will these discussions take and when will a decision be made? – Ending the agreement – How much notice would be given to terminate the agreement? – References – Can you put me in contact with two or three clients who are using your services in my industry/area?